One of the most important decisions entrepreneurs face is selecting what type of entity should be utilized for their new business venture. A business entity is created for an organization’s tax and legal purposes. Whether you choose to be a Corporation, an S-Corporation, a Partnership, a Limited Liability Company or a Sole Proprietorship, your choice will have tax and business implications. All too often business owners set themselves up in business and don’t fully understand the implications of this selection until they begin facing challenges. There are subtle nuances between entities, and in some cases, a company may be able to take advantage of more than one business structure. That’s why it can be extremely advantageous to hire a professional for advice before you decide how to set up your business.
The business structure you select will not only determines who will be taxed and how, but it also determines liability and recordkeeping. The establishment and taxation of business entities varies by state. These are the different types of structures to keep in mind when deciding how to set up your organization:
- Sole Proprietorship — A sole proprietorship is the simplest type of business entity. There is just one owner of the company, and the owner is solely responsible for all of its assets and liabilities. This entity is easy to establish and requires minimal record-keeping.
- Limited Liability Company (LLC) — Limited Liability Companies can have multiple owners or “members”. Members of the LLC can report profits and losses in their personal taxes, however, members of the LLC are generally not personally responsible for debt incurred by the LLC. Setting up your business as an LLC can sometimes require less recordkeeping than a corporation, but more than a sole proprietorship. It also offers a lot of flexibility as far as taxation.
- Corporation — The structure of a Corporation is best for large organizations with multiple employees. The Corporation is an independent legal entity owned by its shareholders, and it requires extensive recordkeeping. The shareholders’ personal assets (besides stock in the company) are protected from company debt. Corporations have the advantage of raising capital through stock, and personal and corporate tax responsibilities are completely separate. The pitfall of a corporation is a double taxation.
- S Corporation — To become an S Corporation, you must first be a corporation or an LLC. The S Corporation is an entity that is only designated by the IRS, and it was created for tax purposes only. The S Corporation structure allows profits and losses to pass through a personal tax return, and double taxation between the shareholders and the corporation is avoided. The S Corporation structure is also a great option for a small company, but more record-keeping is required than is necessary with a Sole Proprietorship or LLC.
- Partnership — A partnership is a business entity with more than one owner or partner. There are three common types of partnerships: General Partnerships, Limited Partnerships and Joint Ventures. A partnership is fairly easy to form and may have the added advantage of sharing resources to create capital. However, partners are personally liable for business debt, just as the owner of a sole proprietorship.